c h a p t e r eleven © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. Prepared by: Fernando & Yvonn Quijano Output and Expenditure in the Short Run

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 2 of 49 Output and Expenditure in the Short Run Aggregate expenditure (AE) The total amount of spending in the economy: the sum of consumption, planned investment, government purchases, and net exports.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 3 of 49 The Aggregate Expenditure Model LEARNING OBJECTIVE 1 Aggregate expenditure model A macroeconomic model that focuses on the relationship between total spending and real GDP, assuming the price level is constant.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 4 of 49 The Aggregate Expenditure Model Aggregate Expenditure  Consumption (C)  Planned Investment (I)  Government Purchases (G)  Net Exports (NX)

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 5 of 49 The Aggregate Expenditure Model The Difference between Planned Investment and Actual Investment Inventories Goods that have been produced, but not yet sold. Macroeconomic Equilibrium Aggregate Expenditure = GDP

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 6 of 49 LEARNING OBJECTIVE 2 Determining the Level of Aggregate Expenditure in the Economy Components of Aggregate Expenditure, – 2 EXPENDITURE CATEGORY EXPENDITURE (BILLIONS OF 2000 DOLLARS) Consumption$7,589 Investment1,810 Government1,952 Net Exports-601

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 7 of 49 Determining the Level of Aggregate Expenditure in the Economy THE CONSUMPTION FUNCTION Consumption function The relationship between consumption spending and disposable income. Marginal propensity to consume (MPC) The slope of the consumption function: the amount by which consumption spending increases when disposable income increases.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 8 of 49 Graphing Macroeconomic Equilibrium Macroeconomic Equilibrium on the 45E-Line Diagram

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 9 of 49 The Multiplier Effect LEARNING OBJECTIVE The Multiplier Effect

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 10 of 49 The Multiplier Effect Autonomous expenditure Expenditure that does not depend on the level of GDP. Multiplier The increase in equilibrium real GDP divided by the increase in autonomous expenditure. Multiplier effect The process by which an increase in autonomous expenditure leads to a larger increase in real GDP.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 11 of 49 A Formula for the Multiplier The Multiplier Effect

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 12 of 49 The Multiplier Effect Summarizing the Multiplier Effect 1. The multiplier effect occurs both when autonomous expenditure increases and when it decreases. 1. The multiplier effect makes the economy more sensitive to changes in autonomous expenditure than it would otherwise be. 1. The larger the MPC, the larger the value of the multiplier. 1. The formula for the multiplier,, is oversimplified because it ignores some real world complications, such as the effect that an increasing GDP can have on imports, inflation, and interest rates.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 13 of 49 The Aggregate Demand Curve Aggregate demand curve (AD) A curve showing the relationship between the price level and the level of planned aggregate expenditure in the economy, holding constant all other factors that affect aggregate expenditure.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 14 of 49 Aggregate demand curve (AD) Aggregate expenditure (AE) Aggregate expenditure model Autonomous expenditure Cash flow Consumption function Inventories Marginal propensity to consume (MPC) Marginal propensity to save (MPS) Multiplier Multiplier effect

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 11: Output and Expenditure in the Short Run 15 of 49 Appendix 11A: The Algebra of Macroeconomic Equilibrium 1.Consumption function 2.Investment function 3.Government spending function 4.Net export function 5.Equilibrium condition